Record Options Trading Shows Concern Ahead of $2 Trillion ‘OpEx’

(Bloomberg) — Nowhere better illustrates the feverish sentiment on Wall Street than the equity derivatives market, where trading volumes are breaking records heading into the expiration of $2.1 trillion in options on Friday.

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The monthly event, known as OpEx, has a reputation for fueling volatility as traders and traders rebalance their large exposures en masse. Now, with demand for both bullish and bearish index contracts booming while hedging individual stocks soars in popularity, OpEx comes at a precarious time.

Twice this week, the S&P 500 briefly topped 4,000 — a battleground for traders that has garnered the highest open interest among contracts due Friday. The benchmark has fallen in three of the past four sessions after jumping more than 5% last Thursday as promising inflation data sparked a wave of short covering and call buying. The index fell 0.3% to close at 3,947 on Thursday.

Amateurs and professionals alike have been flocking to short-term contracts to counter the market bump lately, an activity that has had a huge impact on the underlying stocks. This suggests that Friday’s options runoff may expose stocks to further price swings.

Not everyone agrees with the idea that derivatives have this kind of power. But for some market watchers, it’s no coincidence that the OpEx week has seen stocks decline in eight of the past 10 months.

“Options prices and tails have come down sharply and it’s a good opportunity” to add hedges, said RBC Capital Markets strategist Amy Wu Silverman, citing the possibility that entrenched inflation could renew pressure on stocks.

Federal Reserve-induced market gyrations encourage investors to go all-in to place bullish and bearish bets. About 46 million options contracts changed hands each day in November, set for the busiest month on record, according to data compiled by Bloomberg. This is up 12% from the previous month.

The explosion came in part from derivatives maturing within 24 hours. Such contracts made up a whopping 44% of S&P 500 options trading last month, according to an estimate by strategists at Goldman Sachs Group Inc. including Rocky Fishman.

At the same time, hedging activity in individual stocks just exploded. The Cboe stock index soared on Wednesday to its highest level since 1997. From bursts of earnings at tech giants to the uncertain path of the Federal Reserve’s monetary policy, volatility was the only certainty in the market.

However, nothing is ever simple in this corner of Wall Street, giving mixed messages about positioning investors to collect sentiment. For example, judging by the S&P 500’s divergence — the relative cost of puts versus calls hovering near multiyear lows — traders appear more bullish.

And thanks to the short storage duration of options currently in demand, open interest in S&P 500 contracts has grown at a much slower pace, rising only 4% from the day before the last OpEx. Although with 20 million contracts outstanding, open interest was the highest since March 2020.

“We’ve really seen a lot of recent interest from call buyers and short covers,” said Steve Sosnick, chief strategist at Interactive Brokers LLC. “One could argue that it leaves us a bit more exposed to a downturn, but the mood generally remains upbeat. That’s why Fed governors feel the need to constantly remind us of their determination to fight inflation.”

While it’s not easy to get a clear picture of where options investors are, shifts create opportunities for traders.

Easing interest rate volatility will help the stock market remain subdued, according to Goldman’s Fishman. He recommends buying dupes on the Cboe Volatility Index, or VIX, to bet on a possible year-end lull. The Cboe VVIX index, a measure of the cost of VIX options, has been below the 20th percentile of the range over the past decade, an indication of attractive pricing, according to Fishman.

“The low slope and volume of the volume indicate reduced tail risk concern,” he wrote in a note.

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